The Wisdom of Benjamin Anderson

Doug Nolan 


Perhaps it’s the greatest issue confronting today’s global markets. 

It didn’t work in the U.S. in the late-twenties. 

Arguably, it was an unmitigated disaster. 

Beijing has begun moving more aggressively to rein in speculative excess, while continuing its unrelenting furtherance of productive investment. 

Surging commodities prices are problematic for manufacturers along with other sectors, while stoking inflationary pressures throughout the unbalanced Chinese economy. 

China’s apartment Bubble has created monumental financial and economic risks, while exacerbating inequality and societal vulnerability. 

Meanwhile, Chinese officials remain steadfast in their determination to prolong the economic cycle. 

Especially after covid recovery measures, there’s an incredible amount of “money” sloshing around China’s financial system (and globally). 

Unprecedented Credit growth has elevated myriad price levels, particularly throughout the asset markets. 

Meanwhile, Beijing has repeatedly reaffirmed its commitment to “stable” Credit and liquidity management, which at this stage of the cycle basically signifies massive ongoing Credit expansion and over-liquefied “money” markets. 

In perhaps history’s most parlous historical revisionism, Ben Bernanke has professed a view that the Great Depression was the consequence of post-crash monetary policy mistakes. 

In short, the Fed was negligent for failing to print new money in quantities sufficient to recapitalize the banking system and reflate the general economy. 

Bernanke dismisses the Fed’s role in nurturing boom-time excess that over the long cycle fueled deep structural maladjustment. 

Moreover, Bernanke’s analytical framework disregards the momentous role speculative Credit - and associated liquidity excess and Monetary Disorder - played in fomenting both financial and economic fragilities (laid bare in the post-crash landscape). 

May 26 – Bloomberg (Sofia Horta e Costa): 

“China’s battle to maintain order in financial markets is getting tougher as money floods into everything from commodities to housing and stocks. 

In May alone, the government vowed to tackle speculation in metals, revived the idea of a property tax, oversaw hikes in mortgage rates in some cities, banned the mining of cryptocurrencies and played down calls within the central bank for a stronger yuan. 

Authorities are zeroing in on the risks of assets overheating as they maintain a relatively loose monetary policy to support the economic recovery from the pandemic… 

‘The policy trend is now focused on ensuring financial stability,’ said Alex Wolf, head of investment strategy for Asia at JPMorgan Private Bank. 

‘Beijing will want to resolve bubble risks at the outset, in a targeted manner, using strong rhetoric and small adjustments to policy. 

That appears to be enough for now.’”

Bubble risks will not be resolved. 

Unprecedented Credit growth. 

An epic cycle extended by increasingly intrusive government intervention and monetary stimulus. 

Deepening economic maladjustment. 

Monetary Disorder. 

There are clear and ominous parallels to the “Roaring Twenties” – today in China, the U.S. and globally. 

China is the first to move with various measures to rein in speculative excess. 

Notably absent to this point is a decisive shift toward higher interest-rates and broadly tighter financial conditions. 

I have over the years dismissed the Fed’s so-called “macro-prudential” approach in dealing with overheated assets markets. 

Regulatory measures meant to dampen speculative excess will fail in the face of loose money, liquidity abundance and booming securities markets. 

This is especially the case late in the cycle when bullish market psychology and manic behavior have become so well-entrenched. 

Not surprisingly, Chinese markets are not all worked up by Beijing’s pronouncements (Shanghai Composite jumped 3.3% this week!). 

The view holds that officials may tinker, but they wouldn’t dare push matters to the point of risking a Bubble collapse. 

Key aspects of the global environment are reminiscent of the late-twenties. 

There was New York Fed President Benjamin Strong’s infamous “coup de whiskey” in 1927 in the face of mounting UK and global fragilities – monetary stimulus that fatefully pushed already powerful Bubbles to precarious extremes. 

Yet nothing in history can compare to the past 15 months.

Benjamin Anderson (1886 to 1949) was an astute economist (Columbia PhD and Harvard professor) and writer that published the acclaimed Chase Economic Bulletin (over 200 issues!) throughout the 1920s boom. 

The Austrian School heavily influenced his economic framework. 

His tour de force, “Economics and the Public Welfare: A Financial and Economic History of the United States, 1914–1946,” is must reading for those seeking a sound understanding of the forces that led to the 1929 crash and Great Depression.

I’ve attempted to extract insight pertinent to the current environment. 

They apply to the Fed, Beijing and contemporary central banking more broadly. 

Keep in mind that a momentous change in monetary management (Federal Reserve operations began in 1914) played an instrumental role in a boom that culminated with reckless speculative excess and the 1929 Bubble collapse. 

The key parallel to today’s cycle can be found with the creeping adoption of radical central bank activism, highlighted by zero rates and massive open-ended QE.

Benjamin Anderson: 

“The Federal Reserve Act would have worked well had traditional central bank policies been followed, namely, the holding of the rediscount rates above the market rates, and the use of open market operations primarily as an instrumentality for tightening the money market, not for relaxing it. 

The Federal Reserve System was created to finance a crisis and to finance seasonal needs for pocket cash. 

It was not created for the purpose of financing a boom, least of all for financing a stock market boom. 

But from early 1924 down to the spring of 1928 it was used to finance a boom and used to finance a stock market boom.”

“Certainly it was an unwise in the extreme to build upon it an unusual and illiquid kind of bank credit. 

It was unwise in the extreme to adopt a policy which would expand bank credit in capital uses, such as real estate mortgage loans, stock and bond collateral loans, bank investments in bonds, and the like. 

And yet we did these things. 

Had the Federal Reserve System followed orthodox central bank tradition, using no discretion at all but merely obeying the rules, we should have averted the disasters that followed.”

“Where the Federal Reserve banks bought tens of millions for a few days, in connection with the first three liberty loans, they bought hundreds of millions and held them for many months in 1922, 1924, and 1927. 

And where the Bank of England had primarily used its open market operations for the purpose of tightening its money market in prewar days, the Federal Reserve System used them deliberately for the purpose of relaxing the money market and stimulating bank expansion in 1924 and 1927. At a time when unusual circumstances called for extra caution, they abandoned old standards and became daring innovators in the effort to play God.”

“… The culminating episode of 1927, which touched the match to the powder keg and set the uncontrollable forces working which blew us up late in 1929.”

Noland comment: 

Had the boom come to an end in 1927 the financial crash and resulting depression surely would not have been as destabilizing, deep or prolonged. 

Instead, the “coup de whiskey” threw gas on a raging fire, fueling catastrophic late-cycle “Terminal Phase Excess.” 

Tremendous systemic damage was inflicted during the ’27 to ’29 speculative mayhem. 

I have argued Covid’s timing could not have been more pernicious. 

The unparalleled fiscal and monetary response pushed already historic financial and economic Bubbles to perilous extremes – The Everything Mania. 

Stock prices, corporate Credit, home prices, cryptocurrencies, NFTs, collectables, etc. 

Leveraged speculation. 

Derivatives.

Anderson: 

“Stock prices were already high in the summer of 1927. 

There was an unhealthy tone. 

There was a growing belief that stocks, though high were going much higher there was an increasing readiness to use cheap money in stock manipulation. 

The situation was still manageable. 

The intoxication was manifest, not so much in violent behavior as in slightly heightened color and increasing loquacity. 

The delirium was yet to come. 

It was waiting for another great dose of the intoxicant.”

“Our position in 1927 was thus an unwholesome and precarious one. 

We were busy and active, we were making money, there was little unemployment. 

But we were going ahead despite a fundamental disequilibrium, namely, the weakness of the farmers and the producers of raw materials in the absence of satisfactory export trade.”

“Speculation in real estate and securities was growing rapidly, and a very considerable part of the supposed income of the people which was sustaining our retail and other markets was coming, not from wages and salaries, rents and royalties, interest and dividends, but from capital gains on stocks, bonds and real estate, which men were treating as ordinary income and spending in increasing degree in luxurious consumption… 

We could prolong it for a time by further bank expansion and by further cheap money policies, but only at the cost of creating a desperately difficult situation at a later time.”

Noland comment: 

Bernanke and others have asserted Federal Reserve easy money policies cannot be blamed for the pre-crash speculative market melt-up. 

The Fed did belatedly move to raise rates. 

But without a determined focus on orchestrating a systemic tightening of credit, such measures proved an abject failure in restraining late-cycle excess. 

Anderson: 

“The Federal Reserve authorities from early 1928 on pursued an inconclusive policy based on three partially conflicting motives: 

a) the desire to restrain the use of credit for stock market speculation; 

b) the desire not to tighten money in foreign countries and not to pull in more gold from abroad; and 

c) the desire not to let money grow tight in business uses at home. 

The conflict among these policies meant that the efforts at restraint were handicapped and inconclusive, and that the wild speculation ran on for a year and nine months after the restraining efforts began.” 

“Here was a real restraining influence. 

The Federal Reserve authorities were using measures which, on the basis of their past experience, should have sufficed to stop the stock market boom and did suffice to stop the expansion of bank credit. But the boom went on. 

There was a new factor in the situation. 

The public had taken the bit in its teeth. 

The rise in stock market prices and the lure of stock market profits had caught the public imagination... 

Federal Reserve governor Roy Young: 'I am laughing at myself sitting here and trying to keep a hundred and twenty-five million people from doing what they want to do.'”

“When the Federal Reserve authorities tried to withdraw funds from the money market, the market found new and strange sources from which to draw funds. 

So much new money had been created in the period from 1922 to early 1928 that the problem of reabsorbing it and getting it under control was a very difficult one. 

When a bathtub in the upper part of the house has been overflowing for five minutes, it is not difficult to turn off the water and mop up. 

But when the bathtub has been overflowing for several years, the walls and the spaces between ceilings and floors have become full of water, and a great deal of work is required to get the house dry. 

Long after the faucet is turned off, water still comes pouring in from the walls and from the ceilings. 

It was so in 1928 and 1929. 

At a price, the speculator could get all the money that he wanted.”

May 24 – Bloomberg: 

“China stepped up its fight against soaring commodities prices, summoning top executives to a meeting that threatened severe punishment for violations ranging from excessive speculation to spreading fake news. 

The government will show ‘zero tolerance’ for monopoly behavior and hoarding, the National Development and Reform Commission said… 

The push to rein in surging metals prices rippled across markets -- with steel dropping as much as 6% and iron ore tumbling by close to the daily limit -- before prices steadied. 

The warning from the NDRC comes as a broad surge in commodities prices fuels fears that faster inflation could dent economic growth in China and beyond.”

The Bloomberg Commodities Index jumped 2.1% this week. 

Copper surged 4.4%, with Nickel rising 4.4%, Zinc 3.4%, and Aluminum 3.6%. 

Iron Ore added 1.2%. 

Tin prices ended the week at a decade high. 

Jumping 4.4%, Crude posted its strongest weekly gain since April. 

May 28 – Bloomberg (Alfred Cang): 

“China’s efforts to rein in surging commodities prices are likely to be in vain as it’s lost the ability to boss the market around, according to two of Wall Street’s biggest firms. 

The speed of the rebound in demand in advanced economies, particularly the U.S., means China is no longer the buyer dictating pricing, Goldman Sachs… analysts led by Jeff Currie, the bank’s global head of commodities research, said... 

That view was echoed by his equivalent at Citigroup Inc., Ed Morse, who said… that despite China’s efforts to curb price gains, the real supply-demand balance prevails… 

What Beijing is doing is similar to what Washington did in the mid-2000’s, according to Goldman. 

‘When commentators are unable to understand what is driving such a paradigm shift in prices, they attribute it to speculators - a common pattern throughout history, which has never solved fundamental tightness.’”

Chinese officials can be none too pleased that markets scoff at their commodity market pronouncements. 

Beijing’s credibility is on the line – and not just with surging commodities inflation. 

On multiple fronts, officials are attempting to rein in excess without resorting to a systemic tightening of financial conditions. 

Chinese officials are keen to impose some market discipline upon the corporate and local government debt markets – but without unleashing instability. 

They seek to cool housing market excess through “macro-prudential” measures, while acting cautiously to avoid bursting a historic Bubble. 

They are conveying some weakness. 

If Beijing is serious about reining in excess – and defending their credibility – they’ll have to get a lot tougher. Markets Beware.

It’s 1929 – and policymakers – in China, the U.S. and globally - have lost control of Bubble Dynamics. 

At this point, timid measures will not suffice. 

Efforts to rein in speculative excess while promoting productive investment are destined to fail. 

To break deeply ingrained speculative psychology will require pain – yet policymakers rightfully fear a bout of pain could unleash a panic. 

“The public had taken the bit in its teeth.” 

The global “bathtub” has been overflowing for too many years. 

“Fundamental disequilibrium.” 

Beijing, the Fed and the global central bank community “could prolong it for a time by further [central] bank expansion and by further cheap money policies, but only at the cost of creating a desperately difficult situation at a later time.” 

Benjamin Anderson’s analytical framework is as germane today as it was during the waning days of the “Roaring Twenties”.

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